Question & Answer: Just a Paragraph for the discussion…..

Just a Paragraph for the discussion

Imagine you are the controller of a major new tech start-up. Upper management is putting pressure on you to exceed Wall Street’s earnings expectations for the next quarter. You have decided that you have to “cook the books” in order to exceed expectations. Create a scheme to increase earnings for the quarter. Support your scheme with examples

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Expert Answer


To increase net earnings, either revenues for the next quarter are to be overstated, or costs to be understated, or a combination of both needs to be resorted to.

Earnings management, an euphemism for cooking the books or financial manipulation, refers to managing any item in the financial statements in order to give the picture that the manage wants to portray. It can take various forms, and the spectrum may range from recording fictitious sales ( criminal ) to deferring some categories of expenditure, like advertising ( lawful).

To appear successful in the next quarter, you may want to increase income, increase the book value of assets and/or to decrease the book value of liabilities. Some methods that may be resorted to by management ( reproachable) to show higher earnings numbers are :

a. Lower the estimates for uncollectible debts, and keep bad debt expense to the minimum.

b. Do not recognise unearned revenues. Record all amounts received in the next quarter as revenues earned.

c. Recognize revenues for goods sent to distributors and consignment agents.

d. Do not record any accrued liabilities.

e. Leave contingent liabilities alone. They can be taken taken care of once the quarter has come and gone.

f. Defer depreciation charge on assets purchased during the next quarter.

g. Defer advertising expenses to the succeding quarter / quarters.

h. Reduce estimated warranty liability and warranty expense.

i. Restructure an operating lease as a capital lease, so that the operating costs are reduced.

j. If there in inflation, it could be prudent to switch from WAC to FIFO method of valuing inventories.

If all these

k. Stick with the straight line method of depreciation, and do not opt for the accelerated methods. Depreciation expense under the straight line method is lower than the accelerated methods during the earlier years of operation.

l. Raise the estimated useful lives of assets, so that quarterly depreciation charge is reduced.

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